German short selling ban spooks investors

Global markets fell sharply last week after an ill-conceived decision by the German authorities to act unilaterally with respect to a short selling ban sent the euro to its lowest levels since April 2006.

German chancellor Angela Merkel played party politics with the financial markets in an attempt to rally support for the euro bailout package. Her comments that "the euro is in danger" and that the consequences of a failure to act would be "incalculable," as well as criticism from other eurozone leaders about the one-sided nature of the action, nearly sent the single currency over the edge.

The nature of the ban on specific financial stocks has understandably spooked investors. It really begs the question, what do the German authorities know that the market doesn't?

In a nutshell, the actions of Germany over the past few days have done little to reassure investors that there is, or will be, a fully co-ordinated response to dealing with the crisis in Europe over the coming days and weeks.

It was only unfounded rumours that Greece was about to exit the eurozone and the alleged G7 intervention on Wednesday that dragged the single currency back from the brink, which probably prevented a total meltdown.

The euro more or less hit its lowest levels since April 2006 on Wednesday, posting a low of 1.2143 before later rebounding after the Swiss National Bank was reported to be buying euros and selling Swiss francs. At time of writing the euro was trading at 1.2349 against the greenback and 86.30 against sterling. However, while there may be potential for short-term corrective gains for the euro, rallies are likely to be sold very rapidly while this worldwide lack of confidence remains.

Away from Europe there was other news with the release of the US Federal Open Market Committee (FOMC) minutes for April. There were no real surprises with the Federal Reserve raising its growth forecasts for 2010, but the minutes did show that there was no real desire to offload the $1 trillion worth of mortgage-backed securities any time soon, due to the fragile state of the housing market.

US CPI figures for April, which came in at –0.1%, also prompted the retention of the phrase "rates to remain low for an extended period", and make the likelihood of a rise in US rates in the short term unlikely.

Contrary to expectations, initial jobless claims also rose to 471,000 in the week ended 15 May, showing an increase of 25,000 applying for unemployment benefits.

Oil explorer Cairn Energy was a popular stock last week as it prepares for a four-well exploration programme in Greenland this summer.

The sell-off of BP also stabilised above its weekly lows with news that the oil company was getting to grips with capturing 5,000 barrels of oil a day from its leaking well in the Gulf of Mexico. The company may be in choppy waters for a while to come, but it would seem investors are inherently attracted to the more defensive equities in spite of any bad press BP may have faced in the past month.

Commodities-wise, crude oil extended its losses and drifted below a key support of $69.50 this week falling to near seven-month lows as the negative jobless data and the dire weakness in the equity markets sparked worries of an impact on energy demand and called the rate of economic recovery into question. This has been seen as further evidence that risk appetite has retracted.

Palladium had tumbled by 7.8% to $423.70 an ounce to extend its six-day slump, again based on fears that the slower economic growth would negatively affect demand for cars and consumer goods. Platinum also retreated by 5.4% to $1514.70 an ounce.

In emerging markets, forecasts that China would be increasing its base interest rate were revised as the Chinese government sought to cool the property market in the midst of the eurozone crisis.

The Chinese economy expanded 11.9% in the first quarter and property prices rose by 12.8% in April. State-run China Securities Journal stated that the nation could wait until at least the second half of this year to raise benchmark rates.

The embargo on property speculation has been one of the leading factors that caused the Shanghai Composite Index to slide by more than 20% this year.

Announcements from the eurozone and China will be closely monitored over the coming days and weeks as investors will be attempting to gauge demand requirements in the future and ascertain decent fundamental data that will remove – or at the very least dilute – the uncertainty driving market sentiment at present.

Brenda Kelly, James Hughes, Michael Hewson, CMC Markets www.cmcmarkets.ie